Being dumb makes money smart

It sounds like an oxymoron, but in a field where everybody is trying to outsmart everybody and sometimes themselves, doing nothing is an intelligent choice.

‘Doing nothing’ calls out for passive investing i.e a long-term ‘Buy and Hold’ strategy of diversified asset classes where the objective is NOT to beat the market but rather generate at par returns with the market.

The picture above explains the varied passive investment strategies, my most favorite being Exchange Traded Funds (ETFs). It maps the movement of an Index with a small tracking error, many a time surpassing some of the highly skilled investors.

But what might astonish you is that with hundreds of active fund managers and mutual fund houses, how would passive investing play its game?

Well, data suggest that for the last 5 years more than 75% of active fund managers have underperformed their respective benchmarks.

(PS: WITH DUE RESPECT TO ALL THE ACTIVE FUND MANAGERS)

An amateur investor is generally perplexed about the risk associated with markets. The concept of Dollar-cost averaging i.e. to invest a little over a long period of time, helps to mitigate the risk and also improves the performance. Passive investing eliminates the perplexities of what, when, how much to buy and sell.

As an investor, it is quintessential to survive than to make multi-baggers. Just as we survive irrespective of our body cells getting replaced similarly even with companies getting in and out, the index still survives. This is only possible because the index always retains the winners as it follows the concept of survivorship. Consequently,

by watering the flowers and cutting the weeds, the index forms a beautiful healthy garden with a variety of flowers.

Even with more than 90% of churning in Sensex over 21 years, it is generating 14 % CAGR approximately. This phenomenal return is the result of time.

As Nassim Taleb quotes “The resilient resists shocks and stays the same; the antifragile gets better.” Similarly, the winners keep on becoming giants as more dollars get added to them. Passive investing accomplishes the two most important Mantra of investing:

1-Diversification across asset classes and

2-Compounding over time.

As the above data shows there has been faster adoption of passive investing in India pointing out that the active fund managers are finding it extremely difficult to outperform their respective benchmarks. Thus passive investing is getting some impetus.

As John Bogle, the Father of Index Investing rightly said, “The winning formula for success in investing is owning the entire stock market through an index fund and then doing nothing. Just stay the course”.

Well, however boring and dumb this ‘do nothing‘ strategy might seem, it will make your money smart.

Credits – Jana Vembunarayn